Value investing has picked up a lot of pace recently. This is a trend seen especially after stock markets correct and investors’ bet on ‘growth’ backfires. At such times, ‘value investing’ becomes a new fad. But, what does value investing stand for? In simple terms, value investing is about buying fundamentally great stocks at a value that is currently cheap or inexpensive compared to intrinsic value.
So, if you think a stock is worth Rs 100 and it now trades at Rs 60, there is Rs 40 hidden value left to be exploited. Of course, value investing is not a formula for overnight and quick success. It could be quite a while before other investors are ready to pay that extra Rs 40 for your chosen stock. In the mutual fund mart, over the years there have been many ‘value-oriented’ funds. At last count, there were 17 such schemes. But, are all of them really practicing ‘value investing’? There are some fund portfolios with price/earnings ratio fo 21-23 times. The Sensex has a trailing P/E of 23 times. RupeeIQ takes a look at these funds. Read on.
Value funds by merit
Most value-oriented funds typically have some criteria for buying stocks. These criteria are based on valuations. The stock selection criteria are not different for different market conditions. So, these funds buy stocks at 40-50 per cent discount to their estimated fair value, and sell them when they hit the fair value. Basically, if the stock is not cheap, value investing can’t be practiced. This is where it is different from growth investing. In growth investing, the investors and the fund managers are ready to pay premium for earnings growth. So, they are ready to pay more if it comes to that. A value investor or a value fund theoretically doesn’t do that. However, there are some funds who are doing this.
When we speak to fund-houses and fund managers who are ready to pay more, they argue that value investing formulas are flexible. What they mean is that there is no definition of what is cheap, what is expensive. There are no rules. So, it becomes subjective. For instance, you may think that a stock is cheap at 35 times price/earnings (price/earnings is a metric to understand how much you are paying for the stock given each rupee of profit). But another person might feel 35 times price/earnings is too expensive. This is where the confusion is. As long as the stock goes and somebody else is ready to buy at a higher valuation i.e. price/earnings, there is no problem. The problem happens when one investor buys a stock at a high valuation and there is nobody who wants to buy at a higher price.
Nevertheless, let us look at the portfolio valuations of main value-oriented funds. At RupeeIQ, we believe that some basic ground rules must be there for value investing, or else investors might think they are buying ‘cheap’ when they are actually getting exposed to ‘expensive’.
One of the most popular value-oriented funds is Quantum Long Term Equity, which was launched in 2006. The scheme has a portfolio price/earnings of 16.3 times. The Quantum Long Term Equity Fund is extremely conservative and totally against paying more for businesses. It often sits out and accumulates cash if there are not enough opportunities in the market.
Next, let us look at the portfolio P/E of ICICI Prudential Value Discovery Fund. This is a 14-year old fund and is extremely well-known. The fund is the biggest value-oriented fund out here, with assets of over Rs 16,000 crore. Managed by Mrinal Singh, the fund’s portfolio P/E is 19 times. The fund is extremely value-conscious, even though some of its stocks may seem expensive. The fund’s current bias towards large cap may have made it closer to 19 times portfolio P/E. That is still cheaper than the 22 times for the Sensex.
Another fund is the Templeton India Value Fund, which was earlier called Templeton India Growth Fund. The scheme’s 31-stock portfolio has a P/E of 14.7 times, which is definitely cheap. You can also see Aditya Birla Sun Life Pure Value Fund which has a portfolio P/E of 10.7 times.
Value funds with growth aspirations
Now, let us look at those funds that sport very high portfolio P/Es. You might think these are growth funds than pure value funds. We are not sure how these funds are looking at those valuation metrics. Nevertheless, let us have a look at them.
The first fund which caught our eye is the Invesco India Contra Fund, launched in 2007. The Rs 2,615-crore fund has made quite a name for itself. Its 39-stock portfolio has a P/E of 20.7 times. While its cheaper than the Sensex, but any number closer to 21 times starts looking like its not really cheap.
Then, there is JM Value Fund, which has a portfolio P/E of 21.7 times. The Kotak India EQ Contra Fund has a portfolio P/E of 25 times. It has 55 stocks in its portfolio. The Reliance Value Fund has a 64-stock portfolio P/E of 21.6 times. This scheme has a portfolio P/E of nearly 23 times.
As you can see, most of the highlighted ‘value funds’ have portfolio P/Es of 21-25 times. So, a good question to ask are they really value-oriented?
Classical value investing principles also say that one should not see the valuation of a portfolio through one way, for example, P/E.
So, let us use the price/book valuation metric to see how the funds are placed. The Quantum Long Term Equity Fund has a price/book (P/B) ratio as 2 times. ICICI Prudential Value Discovery Fund sports a P/B of 2.3 times. The Templeton India Value Fund has a portfolio P/B of 1.83 times. The Aditya Birla Sun Life Pure Value Fund has a price/book of less than 1.5 times.
The price/book valuations of some ‘value funds’ is quite expensive, just like they are expensive in terms of P/E metric. Invesco Contra Fund has a portfolio P/B valuation of almost 3 times. JM Value Fund has a portfolio P/B of 3.6 times. To put the numbers in context, the 30-share Sensex trailing price to book ratio is 2.9 times.
The Kotak India EQ Contra Fund, which has the highest P/E valuation for its valuation among peers, also enjoys one of the highest P/B valuation ratios at nearly 4 times.
RupeeIQ take – Since cheap and expensive valuations have no accepted definition (even Sebi has no public thought on this), it is always relative and subjective. Fund managers who have high P/E and high P/B portfolios can always say that they are seeing ‘value’ in their holdings and that is how they can justify buying them. But, fund managers who have built their portfolios with low P/E and low P/B holdings often have pointed out that investors should understand what kind of product they are getting into. In a bull market, everything works. But when the bull market reaches its last stage and bears start their game, slightly expensive stories often get hammered even for minor disappointments.